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Cornerstone, Seabridge, Ecuador, Area plays and Valuations

by Lobo Tiggre

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A reader wrote in to comment on my quick take on Cornerstone Capital (CGP.V) and the Cascabel copper-gold project in Ecuador. Normally, I would not take a private discussion public, but he asked questions I could not answer to him alone without risking trouble with the regulators. The questions cover important topics, so, with his permission, I’m answering here for all readers to see.

It started with this comment:

Ecuador was voted the “GO TO Country” for mining in the world as of 2017. Said vote coming at a major mining conference earlier this year!

To which I replied:

I’m bullish on Ecuador as well, but it really does remain an open question. It’s interesting that so many investors and miners have been willing to forgive the past …

It was the next round that brought up several important issues I think are worth teasing apart:

One of the most favored ways to play the markets is to play the trend, Lobo, and one does not have to forgive the past to claim the present. Trends change as does the present. North America is on its way out for a myriad of debt reasons. So, go with the flow… Ecuador represents/is a humongous opportunity!

Think of it another way, BHP has many reasons to make a move on SolGold soon… possibly before the new 43-101 comes out before year end. SolGold has already stated that the reserves could double which could puts their gold reserves in the 18-25 Mil oz range, plus over a billion tonnes of CU…. and they are still drilling with 15 rigs. Supposedly they haven’t even found the outer limits in any direction as yet.

Consider what the same parameters would sell for in the US or Canada. I certainly couldn’t say, but I’d lay odds it would be higher than $0.19-US for Cornerstone’s 23%. Let’s take Seabridge Gold for instance with 60 Mil oz of gold plus several Bil tonnes of copper trading at $13.10. $13.10 divided by $0.19-US for Cornerstone Capital is 69 times to adjust for the different stock prices. 69 times! By December reserves could be, say 5 Mil oz to Cornerstone’s benefit, plus 23% of the copper as well. 60 Mil divided by 5 Mil is a factor of 12 not 69…. that’s a 12-bagger. Correct me if I’m dead wrong, but I’m trying to see for myself the potential for Cornerstone….

85% of my portfolio is in Ecuador right now, Lobo, and that 85% is in three Ecuadorian stocks.

P.S. I think Seabridge is one of the most undervalued mining stocks on today’s market. Don’t you?

First off, I want to stress again that I have nothing against Cornerstone or SolGold (SOLG.L). The Cascabel discovery is significant, and a result of excellent geological work. I was there. I saw it myself.

I remember well the difficult conditions of the early drilling. Everything was hauled up the mountain on mules, sometimes tottering near cliffs, sometimes up to their bellies in mud. Many of the drill holes deviated—others missed when they didn’t. The partners persisted and have outlined a major deposit. They deserve congratulations for a difficult job well done.

But it’s not my job to be a cheerleader. Don’t get me wrong: it’s fine for individual shareholders to be excited about their investments. I mean no disrespect to my reader who asked these questions. But I publish my analyses and people base their decisions on what I write. So I have to be careful. Even when I do think a project is going to be a big winner, I would never try to present it in the best light possible. I know that all projects, even ones that look like clear winners to me, will have problems and risks that must be assessed objectively.

As for Cascabel, it’s important for me not to get too excited about its size or the relatively high grades of its drill results. I do grant that they’re doozies. But size doesn’t matter if you can’t make money mining a deposit. Even the old miner’s adage that “grade is king” is not always right, if high grades come with higher costs. It’s all about margin. And, as I said before, Cascabel is deep, making it an expensive project to build and operate.

How expensive? We don’t know yet—but if it were a slam-dunk for a money-maker, the asset would have been bought by a larger company long ago. Lundin Mining, for example (LUN.TO), would not be afraid of Ecuador at all. Heck, they went after a large copper-gold project in Serbia, and their sister company, Lundin Gold (LUG.TO) went after the world-class Fruta Del Norte discovery in Ecuador…. but not Cascabel.

In other words, while I do think there’s probably some “Ecuador discount” applied to the stock, I think there’s a much larger discount applied because it’s unclear that Cascabel is worth anything at all. And making it bigger—even twice as large—won’t change that. It’s already big enough to matter. Buyers will run their own numbers and they will not act until they see the margins they want.

The comment about Seabridge Gold (SEA.TO) in this context is interesting. I don’t own that stock either, and for pretty much the same reasons. Yes, it’s one of the biggest undeveloped gold deposits in the world, but its large economies of scale have not resulted in high margins. I wouldn’t even call the margins “okay,” as per the 10% internal rate of return (IRR) in the 2016 preliminary economic assessment. In the company’s own higher gold-price scenario ($1,500.oz), the IRR remains a subpar 13.4%. As a general rule of thumb, anything less than 15% IRR is not going to attract the capital needed to build a mine—let alone the $5.5 billion estimated (back in 2016) to be needed to build this one.

The major gold producers seem just as skeptical as I am. That deposit has been a monster among monster-sized deposits for decades—and yet, they have taken a pass on buying it every time it went on sale during a low point in the commodities cycle. So, no, at almost a billion dollars of market valuation for a deposit that may never be mined, I don’t think Seabridge is undervalued.

As for the calculation, it’s a mistake to compare share prices without reference to the number of shares issued.

Let’s say there’s a company that has a million shares of stock, trading at $1. The market is saying the company and all its assets are worth $1 million (assuming no debt and no cash, for simplicity’s sake). Now suppose there’s another company with stock that also trades for a dollar, but it has 200 million shares out. The market is saying this second company is worth $200 million. That’s 200 times more than the first company, even though the share price is the same.

Seabridge’s current market capitalization (share price x number of shares issued) is C$987 million. Cornerstone’s is C$158.1 million. That’s only 6.2 times less than Seabridge, for a deposit that’s got 30 times less copper—and is in Ecuador instead of Canada, has no economic study, has no environmental permit, etc.

Both are amazing discoveries. But now you know why I don’t own either stock.

Let me say more about going with the flow on area plays: I never invest on this basis.

It’s true that when an area is hot, it can boost share prices in companies that have assets in the area—and even those that rush to them late in the game. We saw this in the Athabasca Basin uranium rush a few years ago. We can see it now in the so-called Golden Triangle rush in northern British Columbia today.

It’s also generally true that the best place to look for a new mine is near an old one. “Close-ology” has some basis in geology and that’s relevant to area plays.

That said, an area being a good place to look is only an encouraging start. The fact that a project is in a hot area, or “elephant country,” or is on strike from a major mine, has zero asset value.

If I see value—or ideally, an undervalued asset—in a company that also has an area play tailwind in its favor, that’s great. But I never buy a stock just because it’s an area play. A rising tide may lift all ships initially, but the leaky ones will sink in time. Due diligence is still required.

Also, while I don’t want to get into a political debate of the fate of North America, there’s no question that rule of law is still stronger there today. That’s crucial for mining companies, and I think it should be for their investors as well.

That doesn’t mean I won’t invest anywhere outside of First World, pro-mining jurisdictions. It just means I want a big discount to venture into riskier waters.

Finally, I would never put 85% of my eggs in one basket, no matter how much I liked it. I wouldn’t even do that if the basket were the USA or Canada. A country with a long history of military coups and economically idiotic dictators—but that happens to look better at the moment—is definitely not a basket I want to concentrate my eggs in. And I don’t care how many people voted for it.

Now, I could be wrong. It’s happened before and I’m sure it will happen again. Cornerstone and Seabridge might both prove me wrong. At the very least, shares in both have risen with metals prices, and may well do so again.

My intention is not to beat up on either of these companies—nor my friendly reader. But I do think the issues brought up are important and worth thinking about.

Caveat emptor,

P.S. Readers should not expect me to answer letters often in this free digest. That’s a level of service I think is more appropriate for paying customers. But if you have a question or an idea that would be educational of or general interest, please feel free to send requests in to L@LouisJamesLLC.com.